Risks Apparent as China Remains Preoccupied with Size and Speed

Posted on August 29, 2011, at 7:15 am

Marvin Zhu

China’s government has earmarked a previously unimaginable 2 trillion yuan (about $300 billion) to build the world’s largest national high-speed railway network. So far, only about half of the total planned route distance of 25,000 kilometers (16,000 miles) has been completed. One of the most recent additions to China’s high-speed railway marvel is an express train between Beijing and Shanghai, which opened in June 2011, some two years ahead of schedule.

China’s ambitious “great leap forward” in industrialization and modernization has been understandably making headlines around the globe. However, these glowing platitudes abruptly turned somber on July 23, 2011, when one of the celebrated Beijing-Shanghai high-speed railroad trains crashed, killing 40 people and injuring some 200 others.

While bad weather and a subsequent system failure were found to be the main causes of the crash, some people speculate that the haste with which the railway was built—driven by thought of generating fast profits and political goodwill—should not be overlooked as a mitigating factor. China has been operating for some time on a progressively “build bigger, go faster” agenda, one where safety and reliability are not always given top priority.

Automotive Industry Caught in Bigger, Faster Tailwind

For more than a decade now, the “build bigger, go faster” mantra has prevailed in China’s automotive industry as well. Ever since China supplanted the US as the world’s largest automotive market in 2009, industry players have been in a fierce race to expand. Over the past two years alone, trillions of yuan have been invested in the car-making business, as automakers race to ramp up production. This frenzied expansion is expected to raise China’s vehicle production capacity to 31 million units by 2013, nearly doubling total sales recorded in 2010.

Global OEMs operating in China have been aggressive in expanding production. Already accounting for roughly half of total annual light-vehicle production, their joint ventures have increased capacity by 5.4 million units during the past 4 years. Hyundai and Volkswagen, for example, plan to add about 1 million units, while Nissan and GM will add just over one-half million units each by 2013. Remarkably, this expansion pales in comparison to Chinese OEMs, who have added nearly double that capacity during the same period.

Currently, the average capacity utilization rate of China joint venture automakers is 96%. Leading OEMs, such as Shanghai VW, FAW-VW, Shanghai GM, and Dongfeng Nissan have indicated they are running at 130% capacity, with some production lines running on three shifts, 7 days a week.

Grand Expansion Plans are in the Pipeline

Companies that plan to expand vehicle production , however, need to meet certain official requirements. China’s National Development and Reform Commission now requires that any automaker wanting to set up a new production plant in a place different from its existing one needs to build either a new-energy vehicle or a local brand of the JV. For example, FAW-VW—one of the first and largest JVs in China—didn’t get the green light for their new Foshan plant until they promised to roll out Kaili, a local brand belonging to the JV. Its first vehicle is set to be an electric car.

Chinese OEMs, on the other hand, are much less constrained than their foreign counterparts. While Beijing still would like Chinese OEMs to make use of the existing capacity through a merger or an acquisition before a new plant is allowed to be built, this requirement is not followed that strictly.

While capacity utilization rates at Chinese automakers are only about 60%, Chinese OEMs, especially the state-owned ones, are also aggressively looking to expand. Chang’an Group, which has already added capacity for 1 million units in the past two years, is planning to add another one million units of capacity by 2014. SAIC Group, including its own passenger-vehicle business and the three-party JV SAIC-GM-Wuling, will double its total capacity from 1.2 million units in 2009 to 2.5 million units by 2014. Meanwhile, Chery, Dongfeng, and FAW have their grand expansion plans in the pipeline as well.

While the desire to expand is understandable, in the race to become the biggest builder of all, quality is often compromised. Quality problems hit FAW and Dongfeng, for example, causing sales to fall, and compelling the automakers to cut prices. Chang’an and Wuling, meanwhile, have seen their inventories grow as a result of the decline in mini bus demand, following the expiration of government subsidies.

Despite the challenges and the high cost of some of these expansion plans, the aggressive drive for growth continues. Apparently, size and speed matter the most for decision-makers at China’s state-owned automakers as these automotive company leaders seek approval at the expense of quality and safety.

Still, there are a few independent Chinese manufacturers, such as Geely and Great Wall, that are adding new capacity while also trying to ensure the quality of their products. And, as word of their quality increases, so does their production and sales. As all around them local competitors seek to become bigger and faster, their commitment to quality allows them to stand out from the rest.—Marvin Zhu, senior market analyst at J.D. Power Asia Pacific, Shanghai, China